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How a ‘Quality of Earnings’ exercise helps in getting an M&A deal done

Bob Wolter

Bob Wolter is a mergers and acquisitions advisor for Cornerstone Business Services, Green Bay, Wisconsin. He contributes this column exclusively for Cheese Market News®.

Let’s be honest, most M&A deals don’t fall apart because someone wakes up one day and decides they don’t like the opportunity anymore. Deals fall apart because doubt creeps in, and doubt almost always centers around one thing — the earnings.

The buyers may love the market, they may believe in the growth story, they may even be excited about the leadership team, but if they aren’t confident in how the business makes money and how much of that money is repeatable, the deal starts to wobble.

That’s where a “Quality of Earnings” (QoE) exercise becomes incredibly important. Not so much as an accounting exercise, not as a technical box to check, but as a practical tool that helps deals move forward and ultimately get done.

• Buyers don’t buy stories, they buy cash flow

When a business goes to market, the initial conversation is often framed around the opportunity. “We’ve grown fast,” “our margins are strong,” “our customers are loyal” — and that may all be true. But when a buyer evaluates a deal, they’re not asking, “Is this a good business?” They’re asking: “What will this business reliably earn under our ownership?” That’s a very different question, because most privately owned companies don’t report earnings in a way that reflects economic reality.

Financials may include owner compensation decisions, personal expenses run through the business, one-time projects, pandemic-era anomalies, delayed investments and time-related revenue spikes. None of this is unusual. It’s how real businesses operate. But to a buyer, it creates uncertainty, and uncertainty slows deals down.

• The gap between LOI and close

One of the most dangerous stretches in any transaction happens after the Letter of Intent (LOI) is signed. At that point, everyone is aligned in principle. The headline valuation is agreed upon, and the excitement is real.

Then due diligence begins and suddenly the buyer starts asking deeper questions. Are the margins sustainable? Are the customers recurring? Is the working capital sufficient? Was last year a peak or the new normal? Without a QoE, the seller is now reacting to these questions in real time. Each answer may be accurate, but when responses happen piecemeal, it creates friction. The conversation shifts from “Here’s how the business performs” to “Let us explain why that number looks that way.” The explanations begin to pile up, and confidence starts to erode.

• A QoE brings clarity early

A QoE exercise helps eliminate this reactive dynamic. Instead of waiting for buyers to discover adjustments, the seller proactively clarifies what the business actually earns, which costs are one-time, which revenues are timing-driven, which margins are sustainable and what normalized operations look like. It creates a bridge from reported EBITDA (earnings before interest, taxes, depreciation and amortization) to true operating EBITDA. That bridge matters, because once everyone is working from the same understanding of earnings, the conversation shifts from validation to value creation.

• Buyers fear surprises more than lower numbers

Buyers are usually not afraid of a slightly lower EBITDA. What they fear is a number that keeps changing. If due diligence reveals that earnings are overstated, even unintentionally, the buyer doesn’t just adjust the model, they start asking questions. What else might change? That’s when a re-evaluation happens. The valuation gets adjusted downward, escrows increase and deal terms tighten — not because the buyer wants to be difficult, but because they now perceive risk. A QoE reduces that risk by aligning expectations early.

When due diligence confirms what’s already been validated, confidence grows instead of shrinking.

• Financing depends on confidence

In many transactions, especially those involving private equity, lenders play a major role, for they don’t fund potential, they fund cash flow. Lenders want to know how stable the earnings are? How predictable are the margins? How much working capital is needed to support growth, and what capital expenditures are truly required?

A third-party QoE gives lenders comfort that the earnings they’re underwriting are real and repeatable. Without it, debt capacity could shrink, and when leverage decreases, buyers often have to revisit price just to maintain their return expectations. That’s how deals that seem solid begin to unravel.

• It keeps competitive tension alive

If a business attracts multiple buyers, the goal is to maintain strong competition. Competition weakens quickly when uncertainty rises. If bidders are unsure about earnings quality, each will apply their own risk discount. Some may walk away; others may submit more conservative offers. A QoE creates a shared baseline. Now bidders aren’t debating what the company earns, they’re competing on how much value they can create.

That’s a much healthier dynamic that helps keep deals moving forward.

• It helps bridge the founder-buyer divide

Many founder-led businesses succeed through experience and instinct. Decisions are made based upon relationships, opportunity and long-term thinking, not necessarily with institutional reporting in mind. Buyers, especially financial sponsors, operate differently. They rely on structured reporting, predictability and repeatability. A QoE helps translate between these two worlds. It turns operational success into financial clarity. That clarity builds trust. Without trust, even great businesses can feel too hard to underwrite. With verification and trust, they feel ready to transact.

• It supports the deal narrative

Every deal has a story, whether it be about growth trajectory, customer stickiness, pricing strength or operational efficiency. However, stories don’t close deals — numbers do. A QoE supports the narrative with evidence. It demonstrates which customers drive stability, which revenues are recurring, which margins are sustainable and which improvements are structural. This turns the story from a pitch into a proven case.

• It reduces the risk of late-stage disruption

Some of the most painful deal moments happen late in the process. When deal fatigue has set in, when timelines feel stretched, when everyone just wants to get to closing, that’s when unexpected findings can do the most damage. A QoE reduces the likelihood of these late-stage surprises by surfacing issues early, when they’re easier to address. Instead of reacting under pressure, the sellers can resolve questions proactively.

That preserves momentum, which is critical because deals rarely fail overnight. They fade when progress slows and confidence weakens.

• It shows professionalism

Finally, a QoE signals something simple but powerful. Preparedness conveys to the buyer this process is being managed thoughtfully, and that perception lowers execution risk. The buyer becomes more comfortable investing time and resources in the deal process. Oftentimes a QoE accelerates timelines because fewer fundamental questions need to be resolved.

A Quality of Earnings exercise isn’t just about accounting precision, it’s about building confidence in the numbers, the sustainability and what the business will earn going forward. When buyers trust the earnings, valuations hold, financing holds and momentum holds. When these three things hold, deals are far more likely to close. That’s why a QoE isn’t simply part of due diligence, but in many cases, it’s the reason the deal gets done.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

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